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Understanding the rules for cafeteria (Section 125) plans in fringe benefits

Fringe benefits are the additional perks that employers provide to their employees for the purpose of employee retention and attracting top talent. There are many types of fringe benefits like travelling allowance, child assistance, health insurance, retirement plans, disability insurance, etc. All these options can come under the cafeteria plan, which is a type of benefit that allows employees to choose from a variety of pre-tax benefits. Section 125 states the provisions of the cafeteria plan.

In this blog, we will demystify section 125 and understand the rules for the cafeteria plans in the fringe benefits:

Introduction to Section 125 and Cafeteria Plans:

A cafeteria plan, also known as section 125, allows the employees to choose the list of fringe benefits and customize their benefits package. It was established by Internal Revenue Code under section 125. The most common benefits are insurance premiums, dependent costs, and medical expenses.

There are a number of compliance and regulatory requirements that apply to Section 125 plans. The plan must comply with all applicable tax laws and regulations, including the Internal Revenue Code (IRC), the Employee Retirement Income Security Act (ERISA), and the Affordable Care Act (ACA), to ensure that it is in compliance with all applicable tax laws and regulations.

Here are some of the key features of the cafeteria plans:

1. Flexibility: The purpose of the cafeteria plans is to provide the employees with flexibility in choosing their benefits while also providing tax advantages. Employees can choose different amounts and benefits every year according to their needs.

2. Limits: The amount that can be allocated to different benefits is limited. For example, per employee, the amount to be spent on child care can only be up to $10,000.

3. Tax savings: Employees can maximize their take-home pay by paying for benefits before tax. In order for the potential tax savings to be maximized, it is necessary to select as many benefits as possible.

4. Limitations: In cafeteria plans, there are limits to the amount of money that can be allocated amongst the different types of benefits. As an example, a company can spend up to $10,000 on childcare benefits for each employee in any given year.

5. Use it or lose it: Employees are required to use all of their cafeteria plan funds at the end of the year or they will lose any funds remaining at the end of the year. An individual cannot carry over pre-tax funds to the next year if they have not been used previously.

6. Nondiscrimination rules: Before cafeteria plans can provide pre-tax benefits, they must satisfy certain nondiscrimination requirements. Employees must benefit from the plan as a whole and not just highly compensated employees.

Administration of section 125 plans: common mistakes to avoid:

It is imperative that employers do not make some of the common mistakes that can lead to the failure of their Section 125 plans. There are a number of mistakes that employers make, including a failure to inform their employees of their options, failing to document properly the plan procedures, and a failure to administer the plan in a proper manner.

Employers are advised to seek the advice of a qualified benefits consultant or attorney if they want to avoid these mistakes. In this way, they will be able to ensure that the plan is properly structured and operated.


Setting up and administering a Section 125 plan can be a complex task, to ensure compliance with the laws and regulations it is crucial to consult with an expert in the field or an attorney. If you want to learn more about cafeteria plans and taxation of fringe benefits then check out the website of Compliance Prime.

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